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Posted On Saturday, Jan 11, 2020
January 12, 2020
Quantum Equity Team
Chinese proverb ‘May you live in interesting times’ fit very well to year 2019. Financial and economic conditions went many through tops and turns during the year. This applies globally as well as to India.
Year 2018 saw tightening of interest rates globally including 4 rate hikes by US Fed. In contrast 2019 had a backdrop of Sino US trade tensions and fears of recession. Not only did the US central bank cut interest rates 3 times, but also went back on its path of shrinking balance sheet by buying bonds.
Emerging market stocks, bonds and currency had good time during the year. In year before rising global interest rates put pressure on emerging markets as foreign investors exit for better returns in home market. Dollar also strengthens in such times as was seen in 2018.
India’s GDP growth which was forecasted at 7% level for fiscal 2020, has come to a grinding halt. Reported GDP grew 4.5% in Q2 of the fiscal. Similarly, interest rates which were going up in India in 2018 saw a drastic unwind starting from February onwards. India stands among the countries that have cut interest rates the most since 2018. With Government trying to rein in fiscal deficit, it was left to RBI to boost growth by lowering interest rates.
S&P BSE Sensex, the barometer for India’s stock markets touched all time high towards the latter part of 2019. If one digs deeper, there are only a handful of stocks which have driven the stock market. A large portion of stocks have been languishing, leading to a deep polarization. While expensive stocks/sectors have been getting pricier, those at opposite end of spectrum saw their valuations beaten down.
Slowdown in GDP growth especially private consumption can be attributed to many factors. Consumption forms a dominant 60% of GDP On one side the aftermath of IL&FS continues to be felt as funding to NBFC sector has dried down. This applies mainly to names beyond top quality NBFCs. NBFCs were lending heavily in individual segment which came to a naught.
NBFCs were also funding the builders. As their access to loans got choked post Sep’18 events, they withdrew from developer loans. NBFCs met majority of funding needs of latter. With the crunch all developers beyond the top ones saw a sudden stop in construction. Significant portion of rural labourers are engaged in construction and their wages were significantly affected.
Another possible explanation to moribund consumption is decline in net household savings of India. While gross saving rate of households is 17% of GDP, their debt has climbed steadily from 3% to 10% of GDP. Not much growth in income and rising leverage reduced the net savings rate to 7%. Future household income growth is necessary for consumption engine to fire.
Slowdown in the economy was discernible from festive season of October 2018. There were hopes that new Government post Lok Sabha elections would tackle the problems. As code of conduct was in force till elections, not much on policy making was possible. BJP led NDA returned with bigger mandate in May 2019 even as it had landslide victory in 2014.
Union Budget post-election presented on 5th July which had high expectations riding on it didn’t deliver much. While it assured to keep fiscal deficit within 3.3% range, need of the hour was to stimulate aggregate demand. Since both corporate sector as well as individuals were incapable of spending, Government was expected to step in. Economists talk of ‘crowding out’ – government borrowing and spending makes funding costly for private sector. However, ‘crowding in’ does happen even public spending is increased even if breaching fiscal targets.
Government spending on infrastructure by better roads/ports can pull corporate sector to set up factories there. Its welfare spending boosts private consumption and lead to a virtual cycle where companies run out of capacities and incur fresh capital expenditure. Such crowding in is especially relevant to infrastructure anemic country as ours. Given low interest rates globally, Government could have gone for higher fiscal deficit as trade off to higher growth. This wouldn’t have affected cost of borrowing or currency level adversely.
Budget inaction did have serious consequence on the economy. Negative growth which was more prominent in autos, commercial vehicles and residential real estate spread to other sectors as well. Even makers of non-discretionary items such as biscuits and undergarments surprisingly commented on falling sales. A number of steps were announced later during the year. Reviving the housing sector is necessary in near term given the multiplier effect it has on goods, services and employment creation.
In the month of September, income tax rate was cut for corporate India from 34% to 25%. The intention behind doing this was to give boost to the economy. Besides, it would also encourage foreign companies to set up operations in India. It has been seen from other countries that corporate tax cuts don’t help aggregate demand much. Companies use the tax benefit to declare dividend or buyback shares. A better way to address the current problems would have been to cut income tax for individuals or reduce GST rates.
S&P BSE Sensex appreciated 16.5% in calendar 2019. Broader indices such as BSE 200 and BSE 500 had a more modest gain, underscoring that only few stocks were driving market returns. They rose 11.0% and 9.5% respectively. BSE Mid cap and Small cap which were much loved in earlier years had losses of 2.1% and 6.2% respectively. Banking, real estate and telecom were sectors which did well in the year. Metals and auto were drags for 2019.
FIIs pumped in USD 14.5 Bn in Indian equities in 2019 as compared to USD 4.4 Bn outflow in previous year, helped by global monetary easing. Domestic investors also showed faith with inflow of Rs 1.3 Trn during the 11 months of 2019 (Rs 1.7 Trn in 2018 calendar). The year was not good for primary market. IPOs during the year so far have been worth Rs 174 Bn as compared to Rs 311 Bn in 2018.
Corporate earnings growth remains lackluster. Even as market participants have been giving rosy projections since 2014 for strong recovery, the same is still elusive. Effects of demonetization, GST implementation and NBFC crisis continues to linger. In FY20 so far, revenue growth of Indian companies is adversely affected by demand slowdown. Their profitability will benefit from cut in tax rates. However, it is nowhere likely to be near 20-25% profit growth expectation.
Going ahead, abundant monsoon towards later part of year should help economic recovery. Monsoon started late this year hurting growth. Consumption will get a boost with better winter crop. RBI has also been infusing liquidity in the market which was a problem for much time after NBFC crisis. It is expected that housing sector also recovers with a number of measures taken. Corporate earnings should also pick up a lag.
In near term, stock market performance is dependent on global liquidity which remains very abundant as interest rates are falling. Any change in policy would impact stocks. There are a number of sectors whose valuations are beaten down. This should offer support to stock markets generally.
We remain long term bulls on the Indian economy and equities. It is likely to be one of fastest growing economies in the world for many years to come. Consumption and infrastructure investments are themes for India which have long legs, even though they has taken backseat lately. Being a domestic consumption led economy, India is well protected from any global problems.
Retail investors should continue to invest through systematic plans. Those with under-allocation to equities can consider putting lump sum to take advantage. Markets hitting new highs tells only half the story as large number of stocks haven’t participated in the rally. High global liquidity due to central banks’ policies has led to underperformance of value style, which can reverse in complex and turbulent global environment.
Data Source: Bloomberg
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